“On December 2, 2011, two of Wall Street’s top lobby groups launched an assault on a newly reinstated “position limits” regulation, which aims to curb speculation in commodity futures markets–and a key factor behind rising food prices–in the first ever case brought against the Commodity Future Trading Commission (CFTC).
The two lobby groups, the Security Industry and Financial Markets Association and theInternational Swaps and Derivatives Association have challenged the extremely controversialposition limits rule, which the CFTC passed in a narrow 3-2 vote this October. Wall Street has recruited the lawfirm of Gibson, Dunn & Crutcher, whose lawyers Miguel Estrada (among Bush’s counsel in Bush v. Gore) and Eugene Scalia (who overturned a Securities and Exchange Commission rule earlier this year) are determined to hold the scepter of market regulation at bay.
The rule caps the total future interest of a given commodity (such as wheat, corn, soy, etc.) a market participant can hold, aimed at preventing “excessive speculation” in those markets. Position limit supporters argue that their absence in recent years has led to price volatility and price spikes, such as the 2008 food crisis that plunged millions of the world’s most vulnerable people deeper into abject poverty, and rising oil prices which in turn drive up the price of food.
Why Position Limits?
Commodity futures exchanges are stocked with two types of traders: Hedgers and speculators. Farmers have long accepted hedging in commodity futures as a way of hedging risk, by selling off future interests (the earliest derivative contracts) in those commodities the burden of production is shared and the farmer ensured a fair price. But wherever futures exchanges were established the threat of speculation was always near.
Japan was home to the first futures exchange in Osaka in the 1730s, however the action of speculators led to famine and food riots, and over time strict controls were developed to protect both farmers and consumers. Recognition of commodity futures speculation prompted the U.S. Commodity Exchange Act 1936, and position limits were established for 28 commodities markets.
By the early 90s free trade ideology had exposed much of the Third World to cheap agribusiness exports. Secret exemptions from position limits for a new Goldman Sachs commodity index fund were allowed on the rationale that they too constituted bona fide hedging. Sixteen other large institutional investors soon received the same exemption. By 2004, cracks started to show in the housing market, and investors began moving money into commodities, spawning an enormous, unregulated and extremely profitable “shadow market.”
By purchasing huge amounts of imaginary wheat, corn, rice or any other commodity andsitting on the contracts for long enough to create an artificial price shock, these enormous “noise” investors were able to impact the price of future contracts to such an extent that real prices followed suit. One congressional staffer estimated that by 2008 80 percent of the market was made up by speculators.
As huge amounts of money entered these markets price volatility went critical. Real prices of Third World staple foods saw unprecedented rises–between 2005 and 2008 maize nearly tripled, wheat increased by 127 percent and rice by 170 percent. Food riots erupted inMozambique and Haiti, killing hundreds. The 2007-08 food crisis drove 40 million people to hunger a further 20 million to extreme poverty. In 2010 these spikes returned, peaking in early 2011. In 2010 Goldman Sachs is estimated to have made $1 billion from these dangerous gambles.
There are other relevant factors influencing these graphic price spikes, such as biofuel subsidies, crop shortfalls from natural disasters and climate change, and increasing demand,especially for resource-intensive food. The financial industry attributes the crisis to these traditional “supply and demand fundamentals,” and their complaint highlights these fundamentals as driving price volatility. However, despite the vocal protestations of lobby groups in Washington and their vociferous report writing, a growing body of academic literature has observed the dynamic at work.
A Battle of Ideas
The current complaint alleges that the CFTC misinterpreted the existing law, mistaken in believing it was required to institute position limits. Comments from former Commissioner Michael V. Dunn (who stepped down in October) demonstrate this confusion, claiming that although he couldn’t logically justify passing position limits, he believed he was bound to it. Wall Street argues the limits are required only “as appropriate” if “necessary to diminish, eliminate, or prevent” “any undue and unnecessary burden on interstate commerce” caused by “[e]xcessive speculation.” First you must prove the limits’ necessity, and then establish limits as appropriate….”